Strategically Speaking January 2016: Does Incentive Compensation Incentivise the Right Behaviours?

In this series, Palladium asks expert strategy practitioners to share their experiences and opinions. We asked:

Many organisations use variable compensation to incentivise better performance. The underlying assumption – that people will work harder to earn more – sounds like common sense, and in many cases it works well. But is that all there is to it?

Incentive compensation also risks incentivising the wrong behaviours. If performance targets are the basis of compensation, why agree to stretch targets? If compensation plans are time-bound, why focus on long-term strategic initiatives that won’t pay off until next year, or later? If performance is measured on the financial dimension alone, why invest in the non-financial drivers underpinning that performance?

So how can an organisation design incentive compensation systems to reward employees for executing the strategy without encouraging dysfunctional behaviours? Or is incentive compensation the answer at all?